Reviewing Business Structure in Light of Tax Changes

The difference between personal and business tax rates is a factor that often influences a business owner’s choice of organizational structure. Thus, recent tax changes make it a good time to recalculate and evaluate your options.

C corporations are taxed at the corporate tax rate, which was permanently cut from a top rate of 35% to a flat 21% starting in 2018. However, owners must pay a second tax on any dividend distributions they receive.

With pass-through businesses such as sole proprietorships, partnerships, and S corporations, profits flow to the owners, who are taxed at individual income tax rates. Individual rates were also reduced, but only for 2018 through 2025, and the top rate is currently 37%.

A flat 21% tax rate may seem like a good reason to convert to a C corp, especially if your income falls into the upper tax brackets for individuals, but there are other factors to consider.

Potential Deductions

Some individuals who receive pass-through income may be able to take a new deduction equal to 20% of their qualified business income. However, when taxable income exceeds $157,500 ($315,000 for joint filers), the deduction may be limited or eliminated altogether depending on a number of factors. For example, high-earning professionals in fields including health, law, accounting, actuarial science, performing arts, consulting, athletics, and financial services are generally not allowed to take the deduction. This deduction is scheduled to expire after 2025.

A C corp may be able to deduct the salaries and bonuses of owners and employees as a business expense. And while individual taxpayers are now limited to a $10,000 annual deduction for state and local taxes, a C corp could potentially deduct all state and local taxes paid by the business.

Planning to Grow, or Sell

Structuring a business as a C corp allows for multiple classes of stock and an unrestricted number of shareholders. This structure often benefits young companies that plan to reinvest a large share of profits and take on investors to facilitate faster growth.

However, an owner who may want to sell in the near future should be aware that a C corp must remain a C corp for at least five years. Like dividends, gains from the sale of a C corp may be subject to tax at both the corporate and individual level.